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The views of the gatekeepers
on the collapse of Trio Capital
The previous chapter noted the criticisms by the regulators of the role
played by the gatekeepers in the case of Trio Capital. In a broad sense,
gatekeepers include financial advisers, lawyers, auditors, custodians,
actuaries, research houses, credit rating agencies and independent experts. The
Australian Securities and Investments Commission (ASIC), in particular, was
pointed in its criticism of the gatekeepers in the collapse of Trio. It largely
attributed the collapse to the failure of the investment manager, the
compliance committee, the compliance plan audit, the research houses, the
custodians and the advisers to detect 'outright dishonest conduct'.
Perhaps unsurprisingly, the various gatekeepers reject this criticism.
This chapter presents their views. It focuses on the committee's evidence from WHK
and KPMG as the auditors of Trio, the professional accounting body CPA
Australia, the peak financial services bodies the Financial Services Council (FSC)
and the Financial Planning Association (FPA), the Australia Custodial Services
Association and the research house Morningstar.
WHK was the auditor of Trio Capital's financial statements 'for the year
ending 2008 and also for the year ending 2009'.
In evidence to the committee, WHK explained that it acquired the business of
the previous auditor, KPMG, and completed the 2008–09 audits using the same
staff and methodology as had been used for the KPMG audits. WHK also noted that
after it had acquired the business from KPMG, it requested the appointment of
offshore auditors to help with the valuation of offshore investments.
A significant portion of the evidence given to the committee by WHK was
'in-camera'. However, the Chief Executive Officer and Managing Director of the
WHK Group, Mr John Lombard, did tell the committee that:
The loss of moneys by investors is deeply regrettable, and in
our view was directly caused by the conduct of Shawn Richard and other parties
with whom he was associated and the apparent failures of Trio Capital to
oversee his conduct as their agent. Mr Richard has acknowledged he misled the
auditor, and the Trio Capital directors have acknowledged that they failed to
properly discharge their responsibilities.
WHK explained that as part of auditors' risk-based approach, there is a
requirement to consider fraud. However, as Mr John Gavens, Principal of Audit
and Assurance at WHK, told the committee, the purpose of the audit is not to
The auditor makes inquiry, uses professional scepticism and
identifies where fraud might occur in relation to a set of financial
statements, both in terms of the misappropriation of funds or the
misrepresentation of financial statements. Where the auditor does not identify
fraud as a significant issue or does not believe that, by virtue of their
inquiries, fraud is a major risk, then the auditor is not required to conduct
further activities in relation to fraud. So the purpose of the audit is not to
detect fraud. The responsibility for detection of fraud, as stated within the
auditing standards, rests with those charged with governance and with management,
and the auditor does have a responsibility to consider fraud. Where there are
potential indicators of fraud then the auditor would conduct additional
activities in relation to that. But they also need at all times to exercise
professional scepticism in relation to whether fraud might exist.
When asked how, in practice, 'professional scepticism' works, Mr Gavens
As part of the audit process the auditor would conduct, for
example, an analytical review of financial information, they would review the
minutes of the board meetings and of the committees and they would be aware of
general economic financial conditions and particular conditions impacting on
the organisation. They would review the culture within the organisation and
make assessments of the integrity of management and the extent to which within
an organisation there was a culture around overriding policies and procedures.
So there is a range of those matters that are considered as part of the audit
process which helps to inform the auditor about the likelihood of information
being provided that may not be what it is represented to be. So it is by virtue
of a range of processes and the accumulation of that information and the
sharing of that information across the audit team that judgments are made in
terms of the environment in which that audit has been conducted and the
veracity of that evidence.
In the case of Trio Capital WHK told the committee that the major risks
for the auditor would be 'the valuation of the financial instruments'.
He added: 'the major risks that the auditor would have concentrated on...would
be in relation to valuation'.
This aligns with the ASIC Chairman's view that the key questions were whether
the assets existed and if so, what was their value.
The committee asked the Managing Director of WHK, Mr Lombard whether
there had been an internal review within WHK of the collapse of Trio and the
auditing of the Astarra Strategic Fund and the ARP Growth Fund. Mr Lombard
There has been a review with the support of our legal team...
I have not read it. The detail of that review is an audit
document, I understand...
I understand the document itself is a detailed document of
which I am not in a position to provide any—...
I have been in the role now for four months and about five
Prior to that I did not live in the country; I was a
non-resident. So I have been going through a significant background and
learning curve myself on this. But I take this extremely seriously. I apologise
that I am not an accountant or auditor, but I have our most senior person here
today to answer those questions.
The committee then asked Mr Gavens, as the Principal of Audit and
Assurance within the company, whether he was aware of the WHK review. He
responded: 'I am aware there is one; I have not seen it'. He added that he did
not know at what level of the organisation the review had been carried out.
The committee asked WHK whether it had been contacted by ASIC or the Australian
Prudential Regulation Authority (APRA) regarding the Trio case. Mr Lombard
replied: 'we have had a document notice from ASIC. That is the only information
that we have received from them'.
...we are waiting for organisations like ASIC to complete
processes that are currently underway...There have been questions about whether
the individual is still working at WHK...the questions surrounding whether we
have done a review of the file and those sorts of things...[W]e believe that we
have acted—and I am advised that we have acted—correctly as auditors in
accordance with Corporations Law and all of the associated standards. That is
the advice I have received. Again, I am not an auditor, but the advice I have
been given is that that is the case, and I accept that advice absolutely as the
managing director of the company.
The committee finds much of WHK's public evidence to the committee
unacceptable. In particular, it is surprising that the Managing Director of a
company responsible for auditing the financial statements of a company involved
in one of the most significant and serious fraud cases in Australian history,
could not have read his own company's internal review of this experience. That
he should appear before a parliamentary committee to give evidence on matters relating
to the collapse of Trio Capital without having read and considered this review
is insulting to the committee.
The committee notes that in February 2012, ASIC accepted an enforceable
undertaking from former WHK auditor Mr Timothy Frazer. ASIC found that Mr Frazer
failed to perform adequately and properly the duties of an auditor, and failed
to ensure each audit was planned and performed 'with an attitude of
professional scepticism'. In a 2008 audit, he had failed to ensure there was
adequate evidence relating to the existence and valuation of investments, and did
not have the requisite understanding of the ASF to identify and respond to
risks of material misstatement. In a 2009 audit, ASIC found that Mr Frazer had
failed to consider the professional competence of the other auditors upon whom
he relied and whether the work of the other auditors was adequate for his
Chapter 2 also noted that KPMG was the auditor responsible for Trio
Capital's compliance plan. Remarkably, its submission to an inquiry into the
collapse of Trio Capital contained not one mention of Trio Capital.
Given that KPMG had responsibility for Trio's compliance plan, the committee
finds this most peculiar. Again, the committee urges ASIC to thoroughly investigate
the quality of KPMG's auditing in the Trio case, if it has not done so already.
Notwithstanding its silence on matters relating to Trio, KPMG's
submission does contain some useful comments on the adequacy of the current
auditing framework. In particular, it considers the operation and regulatory
framework of managed investment schemes, and the functions of compliance plans
and compliance plan auditors. Significantly, the submission makes several
observations regarding compliance committees and compliance plans that are
similar in tenor to those made by ASIC.
The KPMG submission drew the committee's attention to the
'disaggregation of function, authority, accountability and oversight of MI
schemes'. It noted that numerous parties now perform the key operations of these
schemes other than the responsible entity. KPMG argued that:
Whilst the Act [Corporations Act 2001] clearly points to the
RE [responsible entity] as the entity responsible for the MI scheme’s operation,
the law also allows the RE to appoint an agent to do anything that it is
authorised or required to do in connection with the MI scheme. In reality, this
has permitted the business model to be defined by a disaggregation of
functions, authority, accountability and oversight, giving rise to the
potential for diminishing safeguards in the management of the scheme.
KPMG suggested two contrasting possibilities to reduce this
disaggregation of oversight. The first is to mandate a majority of truly
independent directors of the responsible entity (RE) thereby removing the need
for a compliance committee. The second option is to provide stronger
legislative support for the operation of compliance committees which may
include holding management accountable for acting on recommendations of the compliance
KPMG set out in its submission the role of compliance committees and
compliance plans. In terms of compliance committees, it noted that their
purpose is to independently monitor the area performing the primary compliance
function of the RE and report on its functioning to the RE's board. However, it
observed the independent operation of the committee may be compromised given:
...it is the RE who must ensure the proper functioning of the
compliance committee according to one of the content requirements in a
compliance plan, including adequate arrangements relating to the membership of
the committee and how often it meets.
KPMG also noted that compliance committees meet only a few times a year,
leaving the RE's officers or employees better placed to detect breaches on a
day-to-day basis. If these officers or employees are themselves deliberately
concealing a breach of the Corporations Act 2001 or of the scheme's
constitution, KPMG argued that the compliance committee’s ability to detect
such an issue may be impaired. These concerns
give weight to ASIC's suggestion to establish a register of employee
representatives in the financial services industry (see chapter 4).
KPMG and ASIC also seemed to be in agreement that the current law does
not require adequate detail in compliance plans. Chapter 4 noted the
regulator's concerns that section 601HA of the Corporations Act allow for these
plans to be set at a high level, without specific details. Similarly, KPMG's
submission stated that the requirements in section 601HA:
...do not provide detailed qualitative standards. This allows
the compliance plan to be drafted at a high level. Therefore literal adherence
to the compliance plan may not always result in the objectives of the [Corporations]
Act being met. Whilst ASIC may review compliance plans following their
lodgement, ASIC is under no obligation to do so. It is possible that some REs
believe that lodging a compliance plan with ASIC amounts to ASIC ‘approving’
the compliance plan, which is arguably not the case.
In terms of the auditing of compliance plans, KPMG claimed that while
section 601HG(2) of the Corporations Act requires the auditor of the plan to be
a different person to the auditor of the RE's financial statements, this 'increases
disaggregation in the oversight of the MI scheme'. Rather, KPMG argued that:
Having one firm perform both roles provides a better
opportunity for proper communication to occur. This is particularly relevant
given the audit activity involved in fulfilling these audit responsibilities,
including consideration of the RE’s AFSL [Australian Financial Services
Licence] compliance, will often be required to take place in the same time
frame. Combining the different roles of auditing the scheme’s compliance plan
and financial statements and the RE’s financial statements would create more effective
visibility of the scheme’s operation and the RE’s broader commercial
KPMG argued that there is an opportunity to legislate more
prescriptively about the drafting of the compliance plan, as well as what
outcomes it is intended to deliver.
A further issue raised by KPMG concerns auditing standard ASA 240,
titled 'the Auditor's responsibility to consider fraud in an audit of a
ASA 240 was most recently prepared by the Auditing and Assurance Standards
Board (AuASB) in June 2011. KPMG noted that ASA 240 does not comment on how
fraud might be considered as part of a compliance plan audit.
Paragraph 4 of ASA 240 identifies that the primary responsibility for
the prevention and detection of fraud lies with those charged with governance
of the entity and management. It continues:
It is important that management, with the oversight of those
charged with governance, place a strong emphasis on fraud prevention, which may
reduce opportunities for fraud to take place, and fraud deterrence, which could
persuade individuals not to commit fraud because of the likelihood of detection
and punishment. This involves a commitment to creating a culture of honesty and
ethical behaviour which can be reinforced by an active oversight by those
charged with governance. Oversight by those charged with governance includes considering
the potential for override of controls or other inappropriate influence over
the financial reporting process, such as efforts by management to manage
earnings in order to influence the perceptions of analysts as to the entity’s
performance and profitability.
However, paragraph 5 of ASA 240 points out the 'inherent limitations' of
an audit where there is the 'unavoidable risk' that despite proper planning and
conduct of the audit, some material misstatements may be undetected. Paragraph
6 expands on these inherent limitations in the case of fraud, rather than from
error. It states:
...the potential effects of inherent limitations are
particularly significant in the case of misstatement resulting from fraud. The
risk of not detecting a material misstatement resulting from fraud is higher
than the risk of not detecting one resulting from error. This is because fraud
may involve sophisticated and carefully organised schemes designed to conceal
it, such as forgery, deliberate failure to record transactions, or intentional
misrepresentations being made to the auditor. Such attempts at concealment may
be even more difficult to detect when accompanied by collusion. Collusion may
cause the auditor to believe that audit evidence is persuasive when it is, in
fact, false. The auditor’s ability to detect a fraud depends on factors such as
the skilfulness of the perpetrator, the frequency and extent of manipulation,
the degree of collusion involved, the relative size of individual amounts
manipulated, and the seniority of those individuals involved. While the auditor
may be able to identify potential opportunities for fraud to be perpetrated, it
is difficult for the auditor to determine whether misstatements in judgement
areas such as accounting estimates are caused by fraud or error.
Further, KPMG drew the committee's attention to Guidance Statement
(GS) 013—'Special considerations in the audit of compliance plans of
Managed Investment Schemes'—which mentions fraud only in the context of 'inherent
Under a section titled 'inherent limitations', GS 013 states:
Because of the inherent limitations of any compliance
measures, as documented in the compliance plan, it is possible that fraud,
error, or non-compliance with laws and regulations may occur and not be
detected. An audit is not designed to detect all weaknesses in a compliance
plan and the measures in the plan, as an audit is not performed continuously
throughout the financial year and the audit procedures performed on the
compliance plan and measures are undertaken on a test basis.
The committee contacted the AuASB for its comment on the issues raised
by KPMG relating to ASA 240.
The Board noted in its view, ASA 240 is 'very robust' which reflects the
expectations of audit regulators and standards setters in Australia and
Under successive Australian Auditing Standards...one of the
overall objectives of the auditor in conducting a financial report audit is to
obtain reasonable (but not absolute) assurance that the financial report taken
as a whole is free from material misstatement, whether due to fraud or error.
To achieve this, the auditor determines audit procedures that respond to the
auditor’s assessment of the risks of material misstatement whether due to fraud
or error. Audit procedures are not specifically designed to detect fraud, but
are designed by considering the risk of fraud.
The committee notes that KPMG's submission makes no reference to paragraph
12 of ASA 240 or ASA 200, both of which relate to 'professional scepticism'.
'Professional scepticism' is an important concept and one that did not appear
to have been observed by KPMG in its handling of Trio matters. Paragraph 12 of
ASA 240 states:
In accordance with ASA 200, the auditor shall maintain
professional scepticism throughout the audit, recognising the possibility that
a material misstatement due to fraud could exist, notwithstanding the auditor’s
past experience of the honesty and integrity of the entity’s management and those
charged with governance.
ASA 200 states:
An attitude of professional scepticism means the auditor
makes a critical assessment, with a questioning mind, of the validity of audit
evidence obtained and is alert to audit evidence that contradicts or brings into
question the reliability of documents and responses to enquiries and other
information obtained from management and those charged with governance. For
example, an attitude of professional scepticism is necessary throughout the
audit process for the auditor to reduce the risk of overlooking unusual
circumstances, of over generalising when drawing conclusions from audit
observations, and of using faulty assumptions in determining the nature, timing
and extent of the audit procedures and evaluating the results thereof. When
making enquiries and performing other audit procedures, the auditor is not
satisfied with less-than-persuasive audit evidence based on a belief that
management and those charged with governance are honest and have integrity.
Accordingly, representations from management and those charged with governance
are not a substitute for obtaining sufficient appropriate audit evidence to be
able to draw reasonable conclusions on which to base the auditor’s opinion.
An expectations gap
KPMG considered that there is an 'expectations gap' between what the
public believes is the work of a compliance plan auditor, and the work that by
law he or she is actually required to perform. It suggested that this
expectation gap could be reduced 'through AuASB and ASIC working together to
provide additional guidance'. It added that greater guidance or prescription may
be provided in terms of standards relating to the conduct of a compliance plan
This issue, and the matter of 'expectation gaps' more broadly, is considered in
detail in chapter 7.
The Auditing and Assurance Standards Board's view
The AuASB provided answers to a set of written questions from the
committee relating to the Board's role in collaborating with ASIC and APRA and
developing standards that are 'international best practice' while fitting the
Australian context. The Board noted that it conducts 'periodic liaison meetings'
with senior staff of APRA and ASIC, as well as discussions 'from time to time'
on a needs basis. It explained that over the past year, an ASIC Commissioner
and an APRA Member have separately made presentations to the AuASB to discuss
general issues relating to the application of auditing and assurance standards and
issues relating to audit regulation.
The AuASB mentioned that given the overlap between Guidance Statement
(GS) 013—'Special considerations in the audit of compliance plans of
Managed Investment Schemes—and ASIC's Regulatory Guide 132—Managed investments:
Compliance plans—the Board has 'from time to time' raised in discussions with
ASIC as to whether changes need to be made. It added: 'we have not received any
recent advice from ASIC regarding the need to make changes'.
However, the Board did emphasise that it is APRA's and ASIC's practice to
maintain discussions with the AuASB at an 'in-principle' issues level, rather
than raising issues specific to certain entities subject to their regulatory
activities. Further, the Chairman of the AuSAB, Ms Merran Kelsall, emphasised
that she was not able to make any specific comment on the circumstances of the
Trio Capital collapse. She also noted that she could not comment on any
evidence provided by accounting firms who were involved in the audit of the
The Companies Auditors and Liquidators Disciplinary Board
Chapter 4 noted ASIC's view that where an auditor fails to conduct a
compliance plan audit in accordance with the assurance standards, 'there would
appear to be a prima facie case for ASIC to pursue the auditor in the Companies,
Auditors and Liquidators Disciplinary Board (CALDB)'.
The committee's concern, however, is that the regulators' preference appears to
be for enforceable undertakings rather than disciplinary action through the
CALDB. As the Chairman of the Board explained in an answer to a question taken
...in recent times, very few matters have been referred to
the Board. The reason for this is a matter which needs to be addressed to ASIC
or APRA, although to some extent, the use of enforceable undertakings would
explain the reduction in the number of matters being referred.
The CALDB emphasises the importance of the Board's independence from the
processes of supervision, investigation and prosecution of auditors. The
committee agrees that a separate tribunal function is important, but raises the
question as to whether ASIC is making best use of the Board and its role in
maintaining professional standards. The committee notes Treasury's June 2011
options paper titled 'the modernisation and harmonisation of the regulatory
framework applying to insolvency practitioners'. The paper contains three
options to reform the CALDB.
However, it did not deal with the use of enforceable undertakings to resolve
The committee understands that the CALDB is entirely responsive to the
matters it is referred by ASIC and APRA. In this context, it queries why ASIC
has relied so heavily on enforceable undertakings in the past as opposed to
referring a matter to the Board. The committee understands that an enforceable
undertaking is generally an alternative to referring a matter to the Board.
Given the strength of ASIC's criticism of the gatekeepers in the Trio case (see
chapter 4), and the extent of investor losses, it does seem peculiar that Mr
Frazer's case (above) was not referred to CALDB.
The Trust Company
The Trust Company was appointed as the replacement responsible entity of
nine managed investment schemes formerly operated by Trio. In its submission, it
observed that the former operators of the Trio Funds did not appropriately deal
with conflicts of interests that emerged in their capacity as trustee of
superannuation funds, the responsible entity of the registered schemes, and as
associates of the investment manager appointed to the Trio Funds. It stated:
The Trio funds were layered with a series of
cross-investments between super funds and registered schemes and between
separate registered schemes. We observed little evidence to suggest that these
conflicts were adequately managed with the degree of appropriate caution a
reasonable fiduciary would exercise discharging their obligations...There was a
lack of evidence demonstrating that Trio Capital had effective governance, risk
and compliance arrangements.
Significantly, the Trust Company argued strongly against the single
responsible entity regime. It claimed that Trio Capital was 'another example'
of where the single responsible entity has compromised the interests of
investors by acting in the interests of the promoter and failing to ensure
independence. It added: 'a compliance committee does not provide any real time
monitoring or check on the single responsible entity's actions and is similarly
lacking in independence'.
The Trust Company supported this view by noting that the responsible
entity model has been a source of 'consternation, if not strong aversion from
many overseas institutional investors, especially in the UK and Europe'. It
noted that the potential for conflict in the single responsible entity regime
is perceived to be unacceptable by many foreign investors and claimed that the
regime is contrary to international investment standards.
Others submitters, such as APRA, strongly defended the need for the
responsible entity model, noting that a return to a dual responsible entity
structure with a division between trustees and managers would dilute
The views of the financial advisers and planners
Recall from chapter 2 that financial advisers and planners played a key
role in recommending Trio Capital to their clients. There are clear 'regional
clusters' of victims of Trio based on the locality of operations of particular
financial advisers, including Mr Ross Tarrant in Wollongong, the Seagrims in
regional South Australia and Mr Paul Gresham on Sydney's North Shore. The committee
does not know with certainty why these advisers recommended their clients use Trio
products, but the evidence suggests that their recommendations were influenced
by the high commissions paid by Trio.
This section notes the views of the peak financial advice groups as well
as the views of Mr Tarrant.
The Financial Planning Association
The committee received submissions and took verbal evidence from both
the Financial Planning Association (FPA) and the Financial Services Council
The FPA argued that while financial advice 'is likely to have been a
contributor to the instances of consumer loss', the key culprits were the product
providers and the gatekeepers.
It identified a range of these gatekeepers including product manufacturers and
fund managers, platforms, property schemes, ratings agencies and research
houses, investment banks, auditors, accountants of product manufacturers, stockbrokers
and future brokers, Australian Deposit-taking Institutions, insurance brokers
and companies and regulatory agencies including ASIC and the Australian
Competition and Consumer Commission (ACCC).
In the FPA's assessment, the participants involved in the collapse of
Trio Capital 'either did not detect, question or act' on the warning signs
and/or high and abnormal risks associated with the products or provider. It
argued that there is a need for better processes to detect and report concerns
of high and abnormal risks of products and providers are needed across all
financial services participants and gatekeepers to minimise the risks for
The FPA argued that in terms of preventing a repeat of the Trio collapse
and the factors that led to this collapse:
...few of the FoFA [Future of Financial Advice] regulatory
enhancements will have any impact on the prevention of future similar events,
as they have focussed too exclusively on the issues of adviser level activity
and missed the opportunity to engage in a reform debate that would deliver transparent
markets and product safety that would benefit all Australians, ultimately
failing to deliver the effective consumer protection reform that FoFA promised.
Indeed, the Association's submission produced a table presenting its
view of the key problems with the Trio collapse and against each of these,
whether the FoFA reforms will assist. The problems were grouped based on
whether they relate to product providers, research houses, licensees, financial
planners or the regulators. The FPA considered that FoFA would assist for only
two of the 17 problems: the evidence of conflicted remuneration by some
financial planners and the enhanced powers for ASIC to restrict entry into the
Accordingly, the FPA proposed 32 recommendations, which included:
- establishing a standard system for product category labelling;
- a comprehensive system of rating for product risk that ensures
disclosure of key product risks;
increasing the quality and type of disclosures required by
the introduction of a 'best interest' duty to apply to product
manufacturers and fund managers to impose a duty on such providers to consider
the interests of 'consumers as a whole';
- the introduction of a 'best interest' duty to apply to research
houses to impose a duty on such providers to put the interests of the 'consumers
as a whole';
- the introduction of a best interest duty to require AFSL holders
to place the interests of the 'consumer as a whole' ahead of the interests of
- a range of measures to strengthen the criteria, requirements and
assessment process to gain an AFS;
- the development of a framework aligned with ASIC's 'Investing
between the flags' concept (see chapter 6), to address the lack of disclosure
by brokers and product providers in relation to complex financial products
available to consumers, whether retail or non-retail clients; and
- that ASIC undertake a thorough review of the regulation of
research houses operating in Australia, and a requirement that research houses
publish all research reports they produce, whether they are used or not by
product providers; and
- that Self-managed superannuation funds (SMSFs) obtain similar consumer
protections as members of APRA regulated superannuation funds in respect to fraud
The Financial Services Council
The FSC presented a very different view on the need for regulatory
reform to respond to the issues raised by the collapse of Trio Capital. The
committee asked Mr Martin Codina, the Director of Policy at the FSC, if in
his opinion there was anything unique in the Trio collapse that required a
legislative response. He replied:
No... What gives us that view is that there are hundreds of
fund managers in the country which are structured no differently to Trio and
which continue to operate and comply with the law and have not resulted in the
sort of collapse that Trio gave rise to...
I think you have to ask: what data is there to support any
alternative conclusion, particularly having come out of a global financial
crisis, which you would have thought would have exposed—as it did, and we all
remember ASIC's evidence to the former inquiry of this committee; it clearly
exposed some—flawed business models. But there has not been any suggestion or
any evidence, and I have not seen any data, to suggest that what happened in
this instance seems to be widespread or that we have a number of other cases
before the courts.
The FSC told the committee that any legislative response to Trio should
wait until the FoFA and Stronger Super reforms have been fully implemented. As
this committee noted in its inquiry into the FoFA legislation, the FSC supports
the FoFA provisions to enhance ASIC's powers to refuse and revoke licenses and
to ban individuals from the financial services industry. It believes that these
reforms will 'significantly strengthen ASIC’s ongoing compliance monitoring
ability' and provide additional powers to act pre-emptively in situations of
non-compliance before consumers suffer financial loss'.
The FSC also expressed its support for the powers that APRA has to
conduct investigations and issue directions. It noted that under the MySuper
legislation, APRA will have a wider disclosure, efficiency and consumer-focused
Notwithstanding its strong support for these reforms, the FSC told the
committee in August 2011 that in its view, there is 'probably another year to
18 months' of reforms until these reviews will result in 'quite substantive
reform' of the wealth management industry.
It agreed that given this substantial reform program, the government should
wait to see how these provisions operate before considering what action is
needed to address the issues raised by the Trio collapse. As it told the
...in the light of all of the reviews and reform that we are
currently working our way through, we do not see that there is a gap coming out
of all of that that is particular to the subject matter of this inquiry, which
is the Trio collapse, that requires some sort of a unique response or a top-up
response to what is already being done.
Mr Ross Tarrant—Tarrant Financial
Consultants Pty Ltd.
Chapters 2 and 3 mentioned Mr Tarrant, who advised several of his
clients to invest in the Astarra Strategic Fund (ASF) for which Trio Capital
was the responsible entity. However, Mr Tarrant deflected the blame
elsewhere: to the regulators, the auditors, the research houses, the custodians
and the directors of Trio. In terms of the regulators, he stated:
They trusted the financial regulatory framework in the most
sophisticated financial market place in the world. This framework was overseen
and controlled by government watch dogs APRA and ASIC. Despite the
sophistication of our financial system overseen by ASIC and APRA we are all
horrified to learn that our money was sent all over the world from the British
Virgin Islands to Hong Kong to Belize to Anguilla and to the Cayman Islands and
to Lichtenstein and to oblivion.
This entire scenario of devastation was only made possible by
the incompetence and indifference of ASIC and APRA.
In terms of the auditors, Mr Tarrant reasoned:
The first place to look when fraud is discovered is the audit
process. In this case, we had WHK, the fifth largest audit firm in Australia as
the external auditor, and KPMG, one of the largest in the world, as the
internal compliance auditor.
Both internal and external auditors KPMG & WHK signed off
that systems internally were all working properly and that assets and
performance of the fund were fairly stated, giving a true and fair view. The
auditor's opinion was unqualified and compliant with Australian Accounting
Standards, the Corporations Regulations, as well as, with International
Financial Reporting Standards.
Indeed, Mr Tarrant's conclusion was that, in the absence of evidence
that the auditors had raised concerns with ASIC, Trio was unable to determine
the value of its funds, 'there must have been a breach of S601HS(H) of the
Corporations Act'. He noted that while the auditors claimed that they had
prepared their reports with due care and diligence, 'this representation would
now appear to be false'.
In terms of Trio's directors, Mr Tarrant drew the committee's attention
to sections 601FC and 601FD of the Corporations Act relating to the duties of
the responsible entity and the duties of officers of the responsible entity. He
concluded that 'the indifference and incompetence of the directors of ASF and
the disregard for the Corporations Law have created a fertile environment for a
fraud to grow and prosper.'
In terms of custodians and trustees generally, Mr Tarrant was also
sweeping in his criticism, claiming that their 'pivotal roles' have been 'completely
removed'. He noted that while it seems the custodians held a Deferred Purchase
Agreement, there was no proof of existence or value of investor assets.
He argued in his submission that:
It was a condition of Trio's Financial Services Licence that
any custodial agreement be in writing. The Inquiry should seek to review this
agreement in an attempt to determine if the Custodian's both ANZ and NAB could
have performed their role properly.
The custodians' view
A custodian is responsible for the safekeeping of the assets of a third
party client such as a managed investment scheme. It holds legal title to the
assets of the client.
However, as ASIC noted in its submission, 'the custodian only acts on properly
authorised instructions from its direct client or authorised agent' and that
prime responsibility rests with the RE.
Further, custodians are not required to verify underlying assets in managed
investment schemes, only the units in these schemes.
National Australia Trustee Ltd and
ANZ Custodian Services
In the case of Trio Capital, ANZ Custodian Services and the National
Australia Trustees Ltd (a member of the NAB Group) were the trustees and
custodians of the investor assets. National Australia Trustees was appointed by
Trio as custodian on 6 February 2009 after ANZ decided not to continue as
custodian for Trio.
In its submission, ANZ described the timing and nature of its decision
to transfer its Trio Capital custodian duties to National Australia Trustees:
In 2005, ANZ acquired the custody book of Trust Company
Limited (Trust Company). As a result of this acquisition, ANZ replaced Trust
Company as the custodian for custody clients of Trust Company that transferred
to ANZ. Assets held by Trust Company as custodian for those clients were
transferred to ANZ as custodian and were held by ANZ Nominees as sub-custodian.
Trio Capital was one of Trust Company's customers that transferred to ANZ...
During 2008, as part of a strategic review of the custodian
services business customers, ANZ made a commercial decision to exit arrangements
with a number of smaller customers, including Trio Capital. The review included
an analysis of the profitability of individual customers based on fees
generated and operational costs to service those customers. The custodial
arrangement with Trio Capital was terminated and Trio Capital appointed
National Australia Trustees Limited (NAT) as its successor custodian in
February 2009. In accordance with Trio Capital’s instructions, ANZ commenced
the transfer of assets held by ANZ on behalf of Trio Capital to NAT in February
2009. ANZ had transferred substantially all of the custodial assets held by it
under the custody arrangements to NAT by September 2009.
In terms of NAB's involvement as custodian in the Trio case, it told the
committee that it followed standard practices and operating procedures in
relation to asset value reporting. This included reviewing Trio's product
disclosure statement documents to confirm dealings with a licensed custodian
(ANZ Custodians), a site visit to client's place of business, identification
and verification of all authorised signatories to the NAT custody accounts, confirmation
of Trio's AFSL and ASIC registration and meeting the CEO and CFO on separate
occasions to understand their business operations.
A key theme of the NAB's evidence to the committee centred on what
custodians do and do not do, and some confusion about this delineation between REs
and custodians. In its submission, it noted that as a custodian for a RE, it is
responsible to the RE in accordance with its custody agreement. The custody
agreement provisions clearly state that as a custodian, it will not act on instructions
that are considered to be unclear, ambiguous or unlawful. It also noted that in
acting as custodian, the NAB was not undertaking authorized deposit-taking
institution (ADI) activities such as taking deposits.
This theme is revisited in chapter 7 on 'expectation gaps'.
NAB explained that the RE is responsible for investment and valuation
risks of their assets. The custodian sources prices from various providers
which can include the fund manager or administrator of the client's assets.
Where the custodian cannot source a price it will accept a price upon receipt
of a properly authorised instruction from the client. NAB explained that it does
provide its clients with regular, online, on-demand reporting of their assets and
publishes monthly information with respect to those assets that have not been repriced
for at least 5 days. It added: 'In the case of Trio, we followed our standard
practices and operating procedures in relation to asset value reporting'.
The Australian Custodian Services
In its submission to this inquiry, the Australian Custodian Services
Association (ACSA) distinguished between 'custodially held' assets and 'non-custodially
held' assets. ACSA contended that:
...[T]he custodian is only responsible for those assets that
are transferred to it (either by the trustee, the responsible entity, another
custodian on appointment or by way of settlement following a purchase of assets
by the trustee or responsible entity (or by an investment manager authorised to
do so on their behalf)). These assets are known as 'custodially-held' assets.
This means, that generally a custodian will take a transfer of the assets into
its name as registered owner and record the asset into its custody records as
being held on behalf of the client. The custodian will then undertake regular
valuations of the client's assets and provide reports to the client on all
custodially held assets as required under the custody agreement.
If however, the assets of a fund or scheme are not purchased
in the name of, or transferred to, the custodian, then these assets are deemed
to be 'non-custodially held' assets. A trustee or responsible entity might
choose to purchase assets for a fund of scheme but elect not to have these
assets held by their appointed custodian for operational reasons. In this case,
responsibility for these assets rests solely with the trustee or responsible
In the case of Trio, the funds were non-custodially-held assets.
In questioning NAB about its role as a custodian in the Trio case, the
committee ascertained that a custodian may only know if the assets for which
they are acting as custodian actually exist when they are asked to redeem the
funds in order to make a payment. It was unclear whether this would need to be
reported to the regulators and if so, who had the obligation to do so. Mr
Stephen Tudjman, General Counsel MLC for the National Australia Bank, told the
committee that he did not think there is any obligation on the part of the
custodian to report an unusual transaction under the anti-money laundering
legislation. He added:
...that might be a fertile area for the committee to
consider: whether there ought to be an obligation to report to a regulator if
the instructions from the RE carried out by the custodian have produced a
result that there are no assets there. In the scenario you are identifying, the
custodian says to the RE, ‘You’re singly responsible; you do it.’ What are the
additional checks and balances if the RE is not doing the job they should be
This issue is returned to in chapter 7 of this report.
The view of research houses
Research houses are firms that provide objective, independent ratings, recommendations
or opinions on a range of financial products including managed funds, superannuation
funds and insurance products.
ASIC wrote in its submission that research houses have a 'gatekeeper' function
in the market place. The research they produce can influence which products
individual advisers recommend to their clients. ASIC noted that on this basis,
research quality and transparency is important to ensuring that clients receive
A number of research houses were mentioned in submissions to this
inquiry including Van Mac, Van Eyk, Aegis and Morningstar.
Morningstar was the only research house to contribute to this inquiry. In its
submission, Morningstar stated that it had published quantitative Morningstar
Ratings (star ratings) for a number of Trio/Astarra funds between 2005 and the
market announcement of the detection of the alleged fraud in 2009. It relied on
unit prices and distributions reported by Trio/Astarra to Morningstar. On the
basis of this information, the Morningstar Ratings for the funds varied over
Morningstar also noted that it had entered into a licensing agreement
with Astarra Capital in June 2008 whereby it granted to Astarra Capital a 'non-transferrable,
non-exclusive license' to publish Morningstar Ratings on three of Astarra
Capital's funds. This agreement required Astarra to publish the Morningstar
rating definition when publishing Morningstar Ratings. Morningstar did not itself
publish a forward-looking Morningstar Recommendation for any of the
In verbal evidence to the committee, Morningstar confirmed that it does
not seek to identify products that may be fraudulent. The CEO of Morningstar,
Mr Anthony Serhan told the committee that his firm is not paid as an
auditor or a forensic accountant.
As such, Morningstar accepts the information provided to it by product
providers at face value. It would only question the data when it sees 'something
in the flow of that data that would suggest that it is out of sync'.
The committee put to Morningstar that most people have the view that a
Morningstar rating or any other rating system gives credibility to a particular
fund or asset. Mr Serhan responded that the rating system is simply an assessment
of what has been achieved. It is not an indicator of future performance and nor
is it the only indicator of past performance. He told the committee:
The issue comes down to people understanding what the rating
is. I think that relying on a single point rating reference without actually
understanding what that is is fraught with danger. We take disclosure very
seriously. We have documentation on our website and in our materials. We are
quite open about what a star rating is, how it is calculated and what it
measures. We think in that context it is up to the people who consume our
research to avail themselves of the information that we put out there about
what it actually is and what it does measure. Transparency is an important part
of our process.
Research houses and fraud detection
An obvious question arising from the Trio case is whether the fraud could
have been detected earlier. Chapter 2 noted that ASIC was tipped off by Mr John
Hempton who noted the 'improbability of smooth investment returns recorded by
the Astarra Strategic Fund'.
But should the regulators and the gatekeepers have been able to identify the
With the benefit of hindsight, the committee believes that important
signals were missed. An analysis of the response of regulators to the Madoff
fraud identified a similar pattern of indicators or red flags that were missed:
none were in and of themselves the 'smoking gun'.
Mr Hempton stated:
''I find something interesting: you pull on the piece of
string and mostly you find a piece of string. But sometimes you find something
attached,'' he said. ''[There was] nothing that led to the uncovering of
Astarra you could not find on the internet. This was not hard, I just did the
As has been noted, there is no requirement for gatekeepers to check the
underlying value of the assets that financial statements represent. However, it
is not unreasonable to expect them to view sceptically financial statements,
particularly those that appear 'too good to be true'.
The committee considered the possibility of whether an organisation could
be formed with a charter to actively search for fraud, and whether there are
currently the tools to support this endeavour. Morningstar was asked whether it
is possible to track quantitatively the performance of a given fund against
other funds in a way that could detect suspiciously good performance. It
I think it would be possible to construct a calculation that
would help to identify funds that may require further investigation
The committee then queried whether this system could make some judgment
as to whether this good performance was a product of good managing, good luck
or crooked behaviour. Morningstar replied:
Yes, I believe that it is feasible. A lot of people use our
database to do that, and they are not necessarily regulators. A lot of people
use our database to start an investment decision-making process. And quite
frankly, if there is a research analyst involved and you see those sorts of
results, those are the three questions you ask yourself. Are they incredibly
good? That is what you send your team in to try to understand. Or did they get
lucky? And there are a lot of cases where we form a view around luck, yes.
The committee asked ASIC for its view of Morningstar's response to these
questions and whether the regulator believed it would be possible to develop an
algorithm to highlight results that seemed 'too good to be true'. ASIC's
One of the criteria for identifying hedge funds for
surveillance was whether results that we used in a logarithm were too good to
be true. So we already use that in our surveillance. I think I have mentioned
before that, in fact, we were in the process of undertaking surveillance on the
sector at the same time that information came in on Trio. Those criteria were
used; we took the criteria from the Madoff case, plus we added some others, and
Trio was at the top of the list. We are in the process of actually getting more
information from them in addition to what then came in to us.
That is an element. There are other elements in terms of
surveillance of hedge funds that are quite important in perhaps indicating that
there are some problems. Return is one of them. We could probably give you some
idea—we have to be careful about what we tell you in terms of how we are going
to look at it. They are the general criteria.
There was, however, some scepticism that an algorithm could be an
all-powerful instrument to guide ASIC's decision-making:
...with the accounting surveillance project we look at 500
entities. There are about 2,200 listed entities and there are about 5,000—I
think, off the top of my head—managed investment schemes. We do need to take a
risk based approach.
As to whether you could have an algorithm that would pick up
these sorts of things, personally, I am a little bit sceptical. I have seen
lots of algorithms in the regulatory world over the years and they do not
always operate as you might think.
Nonetheless, the committee believes that the (growing) complexity of
investments in managed investment schemes does require a similarly complex and
multidimensional approach to detecting fraud. This point was well made in a
2010 paper by Professor Michael Drew and Dr Jacqueline Drew of Griffith
Our reflections on the Madoff case indicate that approaches
to fraud, particularly those that seek to detect fraudulent activity as a
result of Ponzi-like schemes, need to employ a multi-dimensional approach to
fraud detection, acknowledging the complementarity of internal and external
controls. If a system of fraud detection, which embodies a more proactive,
preventative approach is to be achieved, further work needs to be done on
developing a systematic approach which allows simple, effective and timely
detection of multiple ‘smoking guns’. In Madoff's case, the GFC was a
significant trigger in uncovering a veritable cache of weapons.
The committee believes the active detection of investment fraud in
relation to Australia's superannuation funds should be accorded high priority.
It is quite possible that other fraudulent schemes exist among the 16 000 funds
currently in the Australian market place. Clearly, the current system of
gatekeepers did not work in relation to the Trio funds. There is no reason to
believe that this system will be any more successful in detecting fraud in the
future, particularly given the growing pool of superannuation funds under
investment in Australia.
The committee recommends that consideration be given to improving the
active detection of investment fraud through systems that can identify
'outlying' patterns in investment performance. To this end, the committee
encourages partnerships between the regulators and experts in the private
The evidence presented in this chapter presents many of the gatekeepers that
had responsibility for the oversight of the Trio case in a particularly bad
light. Their role was often passive and unquestioning, relying on the
information provided by the responsible entity and assuming that others in the
regulatory framework would provide the necessary checks.
The committee believes that various aspects of the role that gatekeepers
play within the financial services regulatory regime are in need of
strengthening and improvement. It has particular concerns that gatekeepers are
not notifying the regulators of suspicious behaviour, that there are inadequate
mechanisms to check the accuracy of information provided by the responsible
entity and that investors have an often mistaken belief in the quality and
rigour of the services that the gatekeepers provide (see chapter 6).
The committee is pleased that ASIC recognises these various points of
weakness and has a forward work program to address these issues. It urges ASIC
to follow through on those areas it has identified as needing reform,
particularly the regulatory guidance on and auditing of managed investment
scheme compliance plans, the measures to strengthen the AFS licensing regime,
the review of custodian businesses and options to improve the quality and
independence of research reports. The committee will, as part of its statutory
responsibilities to oversee the work of ASIC, monitor the implementation of
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